Quiz 3: Preparing Your Taxes

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Progressive tax structure: Progressive tax structure is a tax structure in which the larger the amount of taxable income, the higher will be the rate at which it is taxed. If your taxable income is large then you will have to pay tax at higher rate. Main features of progressive tax structure: • Personal income taxes are scaled on progressive rates of tax. • It varies from 10% to 35% depending of your taxable income. • A taxable income moves from lower to a higher tax bracket. • Income taxes are the major source of revenue for the federal government. • The below table present taxable income and the tax rate:

Persons MK and AK are married with a 2-year-old child. They have provided information regarding their earnings and investments for the year and would now like to prepare their tax return , as well as discuss any ways they could reduce their tax liability for next year. 1. First, Persons MK and AK would like to determine the total amount of their itemized deductions. Itemized deductions can include the following: medical and dental expenses; charitable contributions; casualty and theft losses; residential mortgage and investment interest paid; job expenses; and taxes paid (state, local, foreign income, and property). Because many deductions are based on a percentage of adjusted gross income (AGI), it is a good idea to start with that calculation: Based on the information provided in the problem and the AGI we calculated above, we can now determine the itemized deduction for Persons MK and AK: Note: The family's unreimbursed medical expenses cannot be included in their itemized deductions because they do not add up to at least 7.5% of AGI The standard deduction allowed is $11,600 while the itemized deduction calculated above is only $6,339. Persons MK and AK should choose to take the standard deduction instead of the itemized deduction. After calculating the family's AGI and determining it is better to use the standard deduction, we can now prepare their joint tax return: Note : To calculate the family's tax liability, we can use the 2011 Tax Rate Schedules found in Exhibit 3.3. Their taxable income, as calculated above, is $45,950. This means their tax is $4,750 + 25% of the amount over $34,500. The calculation of the tax liability is shown below: 2. As calculated in Part 1, we know that Persons MK and AK itemized deduction was $6,339 as compared to the standard deduction of $11,600. By taking the standard deduction, the family has saved the following amount: The family has saved $5,261 by taking the standard deduction. 3. Persons MK and AK's son holds shares of stock in H Company, from which he received $200 in dividends. However, because he is only 2-years-old, he is not required to file a return. 4. The family would like some advice on tax strategies they may use next year to reduce their tax liability. The following information should be helpful to them: • Maximize deductions : Consider all possible deductions that can be taken - even seemingly small deductions can add up if there a many of them. The family may also want to accelerate or bunch deductions into one tax year instead of several, if it means the itemized deduction amount is larger than the standard. • Income shifting : This technique shifts a portion of a person's income (and corresponding tax liability) to relatives in lower tax brackets through the creation of trusts or gifts of income property. • Tax free and deferred income: The family may want consider utilizing investments that are tax free, such as municipal bonds. In addition, tax deferred income is not subject to tax immediately but rather shifted to a later time. A common source of tax deferred income is income earned from a traditional IRA.